American culture has a deep belief that being average is akin to being a failure. Everybody wants to be above average.
Unfortunately, this desire to be above average rarely works out to our advantage in the field of investing. It leads us to such endeavors as stock picking and timing the market, both of which tend to be counterproductive for most investors.
Index Funds and “Being Average”
As far as I can tell, the primary reason that people are reluctant to invest in index funds is that their egos get in the way.
Ironically enough, with index investing, accepting “average” returns virtually ensures that you’ll come out ahead of the majority of investors.
Another example of ego-related-trouble
What would your thoughts be if I recommended the following investment plan for an investor aged 25?
- 72% in a Wilshire 5000 index fund (tracking the entire U.S. stock market)
- 10% in a European stock index fund
- 5% in a Pacific stock index fund
- 3% in an emerging markets index fund
- 10% in a bond index fund
- Rebalance regularly to maintain this asset allocation
A handful of people might say that it’s a bit on the aggressive side. But I bet most people would say that it looks like a fairly reasonable, well-thought-out strategy for a young investor.
Now what if I had made the following recommendation instead?
- Put 100% of the portfolio into Vanguard’s Target Retirement 2050 fund.
I bet many people would have some qualms about such a strategy. They’d say things like, “It’s too simple.” or “Putting all of my money into a single fund just doesn’t seem wise.”
The odd thing is that these two recommendations are the same thing!
Again, our egos get in the way. We seem to have a perverse desire to make investing more complicated than is necessary. We want to feel sophisticated, and putting 100% of an IRA into a target retirement fund just doesn’t fulfill that need.
My suggestion:
Do your best to set your ego aside when making investment decisions. Don’t do something just to feel smart. With investing, the simplest strategy is often the best one.
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{ 2 comments… read them below or add one }
I love reading your blog because it helps me feel as though I am on the right track
Most of my investing is done in index funds through my IRA. I have a little extra “play” money for other investing, but I never do anything really cool with it. I think the biggest ego boost is knowing that I should be just fine when it comes time to retire.
“I think the biggest ego boost is knowing that I should be just fine when it comes time to retire.”
Well said, Miranda.